Definition: It is the most comprehensive
measure of labor costs and their growth rate. As such, it signals wage
inflation and is closely watched by the Fed. It measures
changes in labor costs for money wages and salaries and noncash fringe
benefits in nonfarm private industry and state and local governments for
workers at all levels of responsibility. Unlike the Average Hourly Earnings
measure of wage inflation, the ECI is not affected by shifts in the composition
of employment between high-wage and low-wage industries or between high-
and low-wage occupations within industries. Thus, the ECI represents
labor costs for the same jobs over time.

Availability: The
last week of the month immediately following the quarter to which they
refer

Direction: Pro-cyclical

Timing: Coincident

Volatility: Modest

Likely Impact of Financial Markets:

Interest Rates: Larger-than-expected
increases are considered inflationary causing interest rates to rise.
The bond market views an increase in ECI as leading to labor cost inflation
that is inflationary if in excesss of productivity growth. A large rate
of growth of ECI also make it more likely that the Fed will increase the
Fed Funds rate that is also bearish for the bond market.

Stock Prices:Higher wage inflation is bearish for the stock market because
high wage growth may reduce profits, increase long-term interest rates
and lead the Fed to increase the Fed Funds rate to stem inflation.

Exchange Rates: Uncertain. High
wage inflation leads to high inflation and loss of competitivenss. However,
it also leads to higher nominal interest rates and real ones too if rthe
Fed tightens; such an increase in interest rates would tend to strenghten
the exchange rate.

Ability to Affect Markets:
Strong as it is an early signal of wage inflation. and is an indicator
closely watched by the Fed.

Analysis of the Indicator:High rates of growth of the ECI (wage inflation) would lead to higher
inflation if the wage growth is above productivity growth. A related measure
of wage cost growth closely watched by the Fed is the Average
Hourly Earnings. Compared to the ECI that is published only quarterly,
the strenght of the average hourly earnings measure it that is published
monthly and is an early indicator of wage growth in the previous month.
However, compared to the ECI, AHE has several weaknesses. First,
the ECI is abroader measure of labor costs as it includes wages and salaries
as well as benefits costs (non cash fringe benefits such as medical benefits).
Second, unlike the AHE, the ECI is not affected
by shifts in the composition of employment between high-wage and low-wage
industries or between high- and low-wage occupations within industries.
Thus, the ECI represents labor costs for the same jobs over time.
Instead, average hourly earnings may increase bacause more workers are
employed in better skills jobs that pay higher high hourly wages rather
than beacuse the same jobs pay higher hourly wage. The first effect due
to a change in the distribution of labor across different jobs is not inflationary;
however, kit leads to an increase in the AHE but not of the ECI. Third,
unlike the ECI, AHE increase also due to transitory increases in wage costs
that are not causes of permanent higher wage costs; for example, increased
use of transitory overtime that is usually paid with higher hourly wages
leads to an increase in AHE but not of the ECI. For all the above reasons,
Greenspan and the Fed give more weight to the quarterly ECI report rather
than the monthly AHE report is deciding whether wage inflation and wage
costs are increasing or not.